There's Reason For Concern Over Zip Co Limited's (ASX:ZIP) Massive 25% Price Jump

Zip Co Limited (ASX:ZIP) shares have continued their recent momentum with a 25% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 68%.

Since its price has surged higher, when almost half of the companies in Australia's Consumer Finance industry have price-to-sales ratios (or "P/S") below 2.3x, you may consider Zip Co as a stock not worth researching with its 4.5x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

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See our latest analysis for Zip Co

What Does Zip Co's P/S Mean For Shareholders?

Zip Co certainly has been doing a good job lately as it's been growing revenue more than most other companies. The P/S is probably high because investors think this strong revenue performance will continue. However, if this isn't the case, investors might get caught out paying too much for the stock.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Zip Co.

Is There Enough Revenue Growth Forecasted For Zip Co?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Zip Co's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 25% gain to the company's top line. Pleasingly, revenue has also lifted 81% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Turning to the outlook, the next year should generate growth of 17% as estimated by the seven analysts watching the company. That's shaping up to be materially lower than the 39% growth forecast for the broader industry.

With this information, we find it concerning that Zip Co is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

The strong share price surge has lead to Zip Co's P/S soaring as well. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've concluded that Zip Co currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. At these price levels, investors should remain cautious, particularly if things don't improve.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Zip Co you should know about.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.